ACCA Performance Management (F5) Certification Practice Exam

What best defines a sunk cost?

1. The cost that is going to be incurred in the future

2. The cost that is already incurred in the past

3. The cost associated with potential new investments

4. The cost that can be avoided by choosing one alternative over another

The correct answer is: The cost that is already incurred in the past

A sunk cost is defined as a cost that has already been incurred in the past and cannot be recovered. This distinction is crucial in decision-making processes, particularly in financial analysis and investment strategies. Since these costs are historical and cannot be influenced by current or future decisions, they should not be considered when evaluating options moving forward. Recognizing sunk costs helps in avoiding the "sunk cost fallacy," where individuals or businesses feel compelled to continue investing in a project due to the resources already committed, rather than making decisions based on potential future returns. By focusing on relevant costs—those that will change based on current decisions—better economic outcomes can be achieved. Understanding what constitutes a sunk cost is essential for effective performance management, as it allows managers to allocate resources wisely without being unduly influenced by past expenditures.